Pulling Back or Pushing Forward?

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five.

Pulling back or pushing forward? We got news of both progress and backpedaling this week. Here to offer his take on the ups and downs is Morningstar markets editor Jeremy Glaser. Jeremy, thanks for joining me.

Jeremy Glaser: Jason, always glad to be here.

Jason Stipp: So what do you have for the Friday Five this week?

Glaser: We’re going to talk about Sprint and Softbank, BAE/EADS, American Express and Wal-Mart, the IMF, and finally Alcoa.

Stipp: Some merger news that we got last week, we thought Sprint may or may not get involved with that. We got some news this week that indicated maybe why they didn’t get involved with that. They are pushing forward in a new way.

Glaser: Last week we were a little bit surprised that Sprint hadn’t thrown their hat into the ring after the surprise announcement that Deutsche Telekom’s T-Mobile was going to be merging with smaller carrier MetroPCS. For a long time, MetroPCS and Sprint seemed to be natural partners. When that didn’t happen, it was a big question mark.

This week we got a better idea of why, and that’s because Softbank, which is a Japanese company and the third largest mobile operator in Japan along with a number of other businesses, is looking to take a 70% stake in Sprint to try to give them the financial strength that they need to help clean up some problems at Clearwire, which is a company that Sprint has a big stake in, and really help Sprint invest in their network, invest in the spectrum that they're going to need in order to be successful and to compete against AT&T and Verizon Wireless for those very lucrative contract customers.

Certainly this deal is far from done. There is probably going to be a lot of regulatory discussion. Our analyst Mike Hodel points out that if this deal were to go through, really almost all the major U.S. carriers, with the exception of AT&T, will have a major foreign owner, have major foreign interest, which could be something that would be disconcerting to some regulators. Even with the cash infusion, it’s still going to be challenging for Sprint to really regain its footing, but I think it's just another chapter in the consolidation we’re seeing in the wireless industry and certainly gives us the information a little bit more color about why Sprint was so quiet last week.

Stipp: In the aerospace sector, we got news of pullback from a big potential merger; that was BAE/EADS. Why did that deal unravel?

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Glaser: This was going to be a blockbuster merger. BAE and EADS were going to come together in order to better compete against Boeing. They’d be able to do that because they could get some synergies from combining a lot of similar operations, potentially close some plants, and really have a better balance between commercial aircraft on the aerospace side and with the defense aircraft as well, which maybe would help balance out some economic uncertainty.

But the governments that have large stakes in both of these companies--including the U.K., France, and Germany--just weren't that excited about it. Certainly they couldn't decide exactly on who was going to end up with how much in each country. There were concerns about outsourcing some of the defense contracts even within Europe. There were concerns about those plant closings, about those job losses that would have to happen for this deal to make sense and for those synergies to actually come from it.

So, given those objections, I think the boards of directors realized they weren’t going to be able to overcome that, and even if they did or were to come to some conclusion, they wouldn't be able to get the cost savings they would need to make the whole thing make sense.

Maybe in a different political climate, they'll be able to come back together and do this deal, but right now it just wasn't possible.

Stipp: Pushing forward with a new plan, an interesting pair--Walmart and American Express--on a prepaid debit card. I think these cards have plenty of critics for good reason in a lot of cases. What's your take on this deal? What was the motivation?

Glaser: This is really a fascinating deal. The prepaid debit card space is growing very rapidly. It's still relatively small, but the growth is coming from customers who are getting pushed out of checking accounts at traditional banks, either out of frustration, out of high fees, or out of new fees that are being instituted--because after some new financial regulations and Dodd-Frank, having these customers with debit cards is just not as profitable for the banks as they once were. Also [there are] some customers who maybe used to be using a check-cashing service who see the relatively low fees on some of their prepaid debit cards as very attractive.

I think that a lot of incumbent players are trying to figure out how they fit into this new world of prepaid debit becoming more important in the payment space, changing very rapidly, while traditional banking also is undergoing its own transformation to figure out how to make that business continually profitable, given some of these new regulations.

So American Express is going to issue a card with Walmart called Bluebird. It's going to carry very low fees. Essentially, if you have direct deposit and you use their in-network ATMs, it will be free, and you'll be able to get your money out anywhere that takes American Express cards, which is obviously somewhat limited. But it shows that American Express is trying to expand its horizons, get away from its very traditional high-end customers and really expand their base. And it also shows that Walmart has not lost its sights on wanting to be a major player in banking. That even if they can't get a traditional banking license, that they can still have customers think of this card and think of Walmart as a place where they can do a lot of their financial transactions.

So I think that it will be interesting to watch how this plays out to see if it gains traction, and I think we're going to see response from a lot of the banks. We're going to see response from a lot of other retailers, and this is going to be an area of hot competition for quite a while.

Stipp: Some bearish notes out of the IMF this week made us wonder if some of their thoughts about austerity might be pulling back a bit?

Glaser: The IMF's economists definitely threw some cold water on the market this week with their updated economic projections. They are expecting that growth in 2012 is going to be 3.3% instead of the 3.6% that they had initially thought. In 2013 they brought their estimate down from 3.9% to 3.6%.

But one of the things that I think caught a lot of people is that they said there is an alarmingly high chance that there is going to be a global recession in the next year, and they see the catalyst for that being that Europe doesn't solve its problems, that the United States falls over the entire fiscal cliff, and that there is continued slowdown in emerging markets. Now they think if that doesn't happen, we're going to be in that 3% global growth range, but they said that a lot of investors maybe aren’t totally keyed into a lot of those risks that are still very much in the global economy.

One area they also talked about was austerity. As you mentioned the IMF is usually a big proponent of austerity. They've developed a lot of these programs, either in conjuncture with the EU or on their own, to say before we're going to lend you money, you need to implement these austerity measures, you need to hit these conditions. They're basically not saying that that's not the way to go any more, but they're definitely pointing out that that austerity has a downside, and the downside is slower growth. And I think they're seeing that growth being this slow, and with the chance for recession happening, that maybe it would make sense to stretch these austerity measures out over a longer time, instead of trying to front load too much of it at once. That's a bit of a change for them. I think it'll be interesting to see how that new way of looking at austerity impacts some of the discussions we're having with Greece and Spain right now in Europe, and impacts some of their loan programs across the world.

Stipp: Alcoa unofficially kicked off earnings season this week with a report that basically met expectations, but a forecast that disappointed. Does this signal a pullback in expectations for earnings looking ahead?

Glaser: I think it might. Alcoa had fine earnings this quarter. But what really caught some people off-guard was that they lowered their expectations for the rest of the year. They said they're seeing China slow down, they're seeing some demand for some of their industrial customers, like in trucking, not looking as strong as they expected, and although there’s strength in aerospace and a few other areas, it's not going to be enough to [keep them from ratcheting] down their expectations somewhat.

Granted, they still think there's going to be growth, … they said they had good visibility on [2013], and they expected to be OK. But certainly, this is not the kind of gangbusters growth you'd associate with a really robust global economy.

I think this idea that we're going to see earnings come in roughly in line, and then also hear management teams say that they see some uncertainty or they see some slowing down across the globe is something that we're going to hear a lot this quarter. Given that corporate earnings have been doing so well for so long, that margins are at very high levels, that earnings are at very high levels, without huge growth to continue to pick up those earnings, you're going to see some reversion back to the mean. Certainly not all the way back to where we were, but I wouldn't be surprised to hear some more disappointing forecasts and disappointing earnings from companies in the coming weeks.